proposed recommendations regarding money market … mmf shares than the amortized cost accounting...

John D. Hawke, Jr.

[email protected]

+1 202.942.5908 +1 202.942.5999 Fax

555 Twelfth Street, NW Washington, DC 20004-1206

January 25, 2013

Ms. Elizabeth M. Murphy Secretary U.S. Securities and Exchange Commission 100 F Street, NE Washington, DC 20549-1090

Re: Presidents Working Group Report on Money Market Fund Reform; Rel. No. IC-29497; File No. 4-619; Comment submitted on the Proposed Recommendations Regarding Money Market Mutual Fund Reform (Docket No. FSOC-2012-0003); Alternative One: Floating Net Asset Value

Dear Ms. Murphy:

Enclosed is a copy of comments we submitted today on behalf of our client, Federated Investors, Inc., to the Financial Stability Oversight Council (the Council) on the Councils recently issued Proposed Recommendations Regarding Money Market Mutual Fund Reform; specifically, Alternative One: Floating Net Asset Value. We ask that our comments be made a part of the Commissions record.

mailto:[email protected]

John D. Hawke, Jr.

[email protected]

+1 202.942.5908 +1 202.942.5999 Fax

555 Twelfth Street, NW Washington, DC 20004-1206

January 25, 2013

The Honorable Timothy Geithner Chairman, Financial Stability Oversight Council c/o Department of the Treasury 1500 Pennsylvania Avenue, N.W. Washington, D.C. 20220

Re: Proposed Recommendations Regarding Money Market Mutual Fund Reform (Docket Number FSOC-2012-0003); Alternative One: Floating Net Asset Value

Dear Secretary Geithner:

We are writing on behalf of our client, Federated Investors, Inc., and its subsidiaries (Federated), to provide comments in response to the Financial Stability Oversight Councils (the Councils) recently issued Proposed Recommendations Regarding Money Market Mutual Fund Reform (Proposed Recommendations or Release); specifically, Alternative One: Floating Net Asset Value.1 The Release would require money market mutual funds (MMFs) to have a floating net asset value (NAV) per share, and would also require MMFs to initially re-price their shares to $100.00 each. In conjunction with this alternative, the Release also proposes to rescind Securities and Exchange Commission (SEC) Rules 22e-3 and 17a-9, which were adopted as part of the SECs 2010 reforms responding to the financial crisis.

As discussed in greater detail in our letter of December 17, 2012, we believe the Council has arbitrarily and improperly invoked its Dodd-Frank Section 120 authority, in an attempt to pressure the SEC to move forward on proposals that a majority of its commissioners found unsupported by data or economic analysis and potentially risky to the financial system. The Council ignored the overwhelming public comments in the SEC docket raising substantial concerns about the very proposals the Council put forward

1 Proposed Recommendations Regarding Money Market Mutual Fund Reform, 77 Fed. Reg. 69455 (Nov. 19, 2012) (Release). This comment addresses Alternative One of the Councils proposals. Separate letters filed this same date comment on Alternatives Two and Three.

mailto:[email protected]

in its Release. We do not believe Congress intended the Section 120 process to be used arbitrarily and in disregard of agency processes, in circumstances where an agency is continuing to grapple with a regulatory issue under its direct jurisdiction, simply because, in this case, the agencys former chair could not muster the votes for proposals that clearly would be ineffective in achieving their primary purpose, would introduce more risk to the system, and would impose significant costs to issuers and investors.

We, nonetheless, appreciate the opportunity to provide comments and, again, call to the Councils attention the significant flaws in the proposed reforms, which should have been abundantly clear from the comment letters, reports and surveys complied in the SECs docket and available to the Council before it issued its Release.

As discussed in the enclosed paper, the Council should not recommend that the SEC adopt the proposal described in Alternative One, for the following reasons:

(1) A floating NAV would do nothing to advance the regulatory goal of reducing or eliminating runs. There is no data to support this proposition and, indeed, the data show just the opposite.

(2) The floating NAV proposal is based on an unproven notion of first-mover advantage, the theoretical risk of which is more appropriately addressed through the operation of existing SEC rules and MMF board authority.

(3) A stable NAV does not create an arbitrage opportunity for MMF shareholders.

(4) The elimination of the stable NAV is wholly unnecessary to address the perceptions of investors, who know and understand that MMFs are investments that are not FDIC insured and may lose value.

(5) A floating NAV would not reflect a measurably more accurate valuation of MMF shares than the amortized cost accounting method currently used by MMFs.

(6) A floating NAV, with a mandated $100.00 initial share price, would not be consistent with the requirements that apply to all other mutual funds but rather would be arbitrary and punitive, and would destroy MMFs as a product.

(7) A floating NAV, for the sake of showing minute variations in value that cancel out over time, would eliminate MMFs as a viable cash management tool by destroying their principal liquidity function.

(8) A floating NAV, for the sake of showing minute variations in value that cancel out over time, also would impose significant operational, accounting and tax burdens on users of MMFs and destroy their utility.

(9) A floating NAV would altogether prevent certain investors who are subject to statutory prohibitions and investment restrictions from using MMFs.

(10) A floating NAV, because of the operational burdens, costs, and other impediments, would substantially shrink the assets of MMFs.

(11) A floating NAV would therefore contract the market for, and raise the cost of, short-term public and private debt financing while potentially destabilizing those markets.

(12) A floating NAV would force current MMF users to less regulated and less transparent products.

(13) A floating NAV would accelerate the flow of assets to Too Big to Fail banks, further concentrating risk in that sector.

(14) The Councils proposal to rescind Rules 22e-3 and 17a-9 would remove important 2010 reforms designed to protect investors.

(15) Instead of focusing on the floating NAV, regulators should consider how MMFs enhanced liquidity has proved to be effective in absorbing heavy redemption requests, and how it has improved the characteristics of the marketplace from 2008.

We urge all members of the Council to review the comments submitted in response to its Release and to give careful thought to the issues discussed in the attached paper as well as those raised by other commenters. We further urge the Council to withdraw its Release.

Enclosure

cc: Ben S. Bernanke, Chairman of the Board of Governors of the Federal Reserve System Richard Cordray, Director of the Consumer Financial Protection Bureau Edward DeMarco, Acting Director of the Federal Housing Finance Agency Gary Gensler, Chairman of the Commodity Futures Trading Commission Martin Gruenberg, Acting Chairman of the Federal Deposit Insurance Corporation Debbie Matz, Chairman of the National Credit Union Administration Elisse B. Walter, Chairman of the U.S. Securities and Exchange Commission Thomas J. Curry, Comptroller of the Currency S. Roy Woodall, Jr., Independent Member with Insurance Expertise John P. Ducrest, Commissioner, Louisiana Office of Financial Institutions John Huff, Director, Missouri Department of Insurance, Financial Institutions, and Professional Registration David Massey, Deputy Securities Administrator, North Carolina Department of the Secretary of State, Securities Division Michael McRaith, Director of the Federal Insurance Office Eric Froman, Office of the General Counsel, Department of the Treasury Amias Gerety, Deputy Assistant Secretary for the Financial Stability Oversight Council Sharon Haeger, Office of the General Counsel, Department of the Treasury Mary Miller, Under Secretary of the Treasury for Domestic Finance Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission Troy A. Paredes, Commissioner, U.S. Securities and Exchange Commission Daniel M. Gallagher, Commissioner, U.S. Securities and Exchange Commission Diane Blizzard, Deputy Director, Division of Investment Management, U.S. Securities and Exchange Commission Norman B. Champ, Director, Division of Investment Management, U.S. Securities and Exchange Commission David W. Grim, Deputy Director, Division of Investment Management, U.S. Securities and Exchange Commission Craig Lewis, Director and Chief Economist, Division of Risk, Strategy, and Financial Innovation, U.S. Securities and Exchange Commission Penelope Saltzman, Associate Director, Division of Investment Management, U.S. Securities and Exchange Commission

Proposal for a Floating NAV for Money Market Mutual Funds: Ineffective in Protecting Against Runs in a Crisis;

Harmful to Investors and the Economy

Comment Submitted for Docket No. FSOC-2012-0003

January 25, 2013

Prepared by Arnold & Porter LLP on behalf of Federated Investors, Inc.

Proposal for a Floating NAV for Money Market Mutual Funds: Ineffective in Protecting Against Runs in a Crisis;

Harmful to Investors and the Economy

We are submitting this paper on behalf of our client, Federated Investors, Inc., and its subsidiaries (Federated). Federated has served since 1974 as an investment adviser to money market mutual funds (MMFs).1

This paper responds to the release issued by the Financial Stability Oversight Council (Council) requesting comment on Proposed Recommendations Regarding Money Market Mutual Fund Reform (Release);2 specifically, Alternative One: Floating Net Asset Value. Under this alternative, money market mutual funds (MMFs) would be required to have a floating net asset value (NAV) per share and would not be allowed to use amortized cost accounting and/or penny rounding to maintain a stable NAV.3 The Release states that the value of MMFs shares would not be fixed at $1.00 and would reflect the actual market value of the underlying portfolio holdings, consistent with the requirements that apply to all other mutual funds.4 The Release describes this alternative as requiring that MMFs re-price their shares to $100.00 per share (or initially sell them at that price), in order to be more sensitive to fluctuations in the value of the portfolios underlying securities.5 The Release proposes a potential transition period of up to five years, in which the Securities and Exchange Commission (SEC) would prohibit new share purchases in grandfathered stable NAV funds after a predetermined date, and any new share purchases would have to be made in floating NAV funds.

While all of the restrictions of Rule 2a-7 would remain, the Release proposes to rescind two existing SEC rules, adopted as part of the SECs 2010 reforms responding to the financial crisis. The first is Rule 22e-3, which currently allows an MMF board to suspend redemptions

1 Federated has thirty-nine years of experience in the business of managing MMFs and, during that period, has participated actively in the money market as it has developed over the years. The registration statement for Federateds Money Market Management fund first became effective on January 16, 1974, making it perhaps the longest continuously operating MMF to use the Amortized Cost Method. Federated also received one of the initial exemptive orders permitting use of the Amortized Cost Method in 1979.

2 Proposed Recommendations Regarding Money Market Mutual Fund Reform, 77 Fed. Reg. 69455 (Nov. 19, 2012) (Release).

3 Release at 69466.

4 Id.

5 Id. The requirement for MMFs to price their shares at $100.00 per share is not consistent with the requirements that apply to all other mutual funds. This issue is addressed extensively in a Letter from Stephen Keen to the Council. Letter from Stephen A. Keen to Financial Stability Oversight Council (Nov. 26, 2012), http://www.regulations.gov/#!documentDetail;D=FSOC-2012-0003-0004. No current law or regulation requires an investment company under the Investment Company Act of 1940 to offer its shares at a particular price.

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and begin an orderly liquidation if the fund has broken or is about to break the buck.6 The Release rationalizes that a floating NAV diminishes the need for MMF sponsors or boards to suspend redemptions or otherwise intervene upon share price declines.7 The second is Rule 17a-9, which allows affiliates of an MMF to purchase portfolio securities from an MMF, which the Release says typically is used to support an MMFs stable price per share.8 The Release rationalizes that since a floating NAV fund is designed to fluctuate in value, allowing this type of support would be unnecessary.9

The Release describes the benefits of this proposal as (1) reducing the perception that shareholders do not bear any risk of loss in an MMF; (2) making MMFs operate like other mutual funds, showing day-to-day fluctuations; (3) removing uncertainty or confusion regarding who bears the risk of loss in an MMF; and (4) reducing first-mover advantage.10 The Release acknowledges, however, that a floating NAV would not remove a shareholders incentive to redeem whenever the shareholder believes that the NAV will decline significantly in the future . . . .11 In short, a floating NAV will not remove the risk of runs. It also acknowledges, but does not size or attempt to address, significant tax, accounting, and operational costs that would result from the proposal.12

In its perfunctory statement of the benefits and costs associated with a floating NAV, the Council largely ignores the extensive record of public comments in the SECs docket on this subject.13 As these comments explain, the stability, diversification, and high credit quality of MMFs over the years has enabled millions of individuals, businesses, nonprofits, and state and local governments to invest significant portions of their liquid assets in these funds with total

6 Release at 69466. See 17 C.F.R. 270.22e-3.

7 Release at 69466.

8 Id. See 17 C.F.R. 270.17a-9.

9 Release at 69466.

10 Id. at 69466-67.

11 Id. at 69467.

12 Id.

13 These comments were filed over a three-year period in response to the SECs 2009 proposed rule on Money Market Fund Reform, the SECs request for comment on the 2010 Report of the Presidents Working Group on MMF Reform Options, and the public statements made by former SEC Chairman Mary Schapiro in which she outlined what she believed a further formal proposed rule would include. Unless otherwise stated, all letters cited in this paper were filed in response to the SECs Request for Comment on the President's Working Group Report on Money Market Fund Reform, File No. 4-619, http://www.sec.gov/comments/4-619/4-619.shtml (letters dated 2010 or later) or the SECs Request for Comment on a Proposed Rule: Money Market Fund Reform, File No. S7-11-09, http://www.sec.gov/comments/s7-11-09/s71109.shtml (letters dated 2009).

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shareholder balances today exceeding $2.7 trillion.14 Individual investors rely upon the convenience of the one dollar per share pricing, which is why investors throughout the U.S. have opposed proposals to require MMFs to float their NAV. As the AARP has stated, the requirement of floating net asset values would radically and detrimentally alter the role and function of money market funds, discourage the use of money market funds for individual investors, and disrupt the financial market landscape for investors.15

In addition, many institutional users of MMFs corporations, state and local governments, and trustees, cannot (by law or investment guidelines) or will not (because of cost, operational, tax, or accounting considerations) use a floating NAV MMF. Indeed, the one dollar per share pricing is critical to the utility of MMFs for a variety of applications involving automated accounting and settlement systems and is incorporated into many automated systems and the interfaces used in these systems.16

Although the Release contains several footnote references to isolated letters and surveys in the SECs comment file, the vast majority of comments were not referenced in the Release and apparently not considered by the Council. The hundreds of individually distinct public comment letters in the SECs docket contained substantial research, data, reports, surveys and other analyses developed over a period of almost two years. Commenters put forward data and research regarding the adverse impact of requiring MMFs to adopt a floating NAV; they also argued strongly that, based on their analysis of the data, the proposal not only would fail to prevent or reduce the risk of runs in a crisis, it in fact could precipitate runs and increase systemic risk.17 The Federal Reserve Bank of New York (FRBNY) in a recent report highlighted these same concerns,18 as did the Presidents Working Group on Financial Markets

14 Investment Company Institute (ICI), Money Market Mutual Fund Assets, Week ending January 9, 2013 (Jan. 10, 2013), http://www.ici.org/research/stats/mmf/mm_01_10_13.

15 Letter from AARP to SEC (Sept. 8, 2009).

16 These uses, discussed extensively in the Appendix, include the following: bank trust accounting systems; corporate payroll processing; corporate and institutional operating cash balances; federal, state and local government cash balances; municipal bond trustee cash management systems; consumer receivable securitization cash processing; escrow processing; custody cash balances and investment manager cash balances; 401(k) and 403(b) employee benefit plan processing; broker-dealer and futures dealer customer cash balances; and cash management type accounts at banks and broker-dealers. Of course, MMFs and their transfer agents are required to have the capacity to redeem and sell securities based on a net asset value reflecting current market conditions, which must include the ability to redeem and sell securities at prices that do not correspond to the stable NAV per share. 17 C.F.R. 270.2a-7(c)(13).

17 Arnold & Porter filed a letter with the SEC on July 17, 2012, copying all members of the Council, in which we detailed the comments, surveys, reports and other data filed with the SEC as of that date. Letter from John D. Hawke, Jr. on behalf of Federated Investors to SEC (July 17, 2012).

18 The Federal Reserve Bank of New York stated, [B]ecause a floating NAV requirement would eliminate what appears to be a key attraction for many MMF investors, such a change might lead to a precipitous decline in MMF assets and in these funds capacity to provide short-term funding. . . . [S]table-value investment vehicles would

Footnote continued on next page

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in its 2010 report on MMFs (PWG Report).19 As stated above, in its own Release, the Council itself acknowledges that while a floating NAV would remove the ability of a shareholder to redeem shares at $1.00 when the market value is less than $1.00, it would not remove a shareholders incentive to redeem whenever the shareholder believes that the NAV will decline significantly in the future, consistent with the incentive that exists today for other types of mutual funds.20

Moreover, although the Release states the transition period would reduce potential disruptions and facilitate the transition to a floating NAV for investors and issuers,21 this contention wholly ignores the asset flows of the MMF industry. MMF investors use MMFs as cash management accounts. Given that 50% or more of the assets held in MMFs may turn over in under a month, the structure of the transition period ensures that most users will have very little time to adjust to the floating NAV.22 As a result, MMF users will rapidly feel the effects of

Footnote continued from previous page continue to pose systemic risks if assets migrate to other, less regulated, less transparent stable-NAV products (such as offshore MMFs and some private liquidity funds). Alternatively, if institutional investors move cash to banks, the banking system might experience a large increase in uninsured, hot money deposits. . . . [A] floating NAV might lead to a steep decline in investor demand for MMF shares and a migration of assets to less regulated vehicles that continue to offer stable NAVs. Moreover, even if MMFs with floating NAVs remain sizable, they might continue to be vulnerable to runs, since investors in distressed funds still would have strong incentives to redeem. Patrick E. McCabe, et al., The Minimum Balance at Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market Funds, Federal Reserve Bank of New York Staff Study No. 564 at 6, 54 (July 2012), http://www.federalreserve.gov/pubs/feds/2012/201247/201247pap.pdf (FRBNY Staff Report). Astonishingly, while acknowledging that a floating NAV cannot be relied upon to address the potential for MMF runs, and further noting the potential for significant adverse economic consequences if such a proposal were adopted, the FRBNY Staff Report nonetheless suggested that regulators could give investors a choice between two types of MMFs: floating NAV funds alongside others that would have stable NAVs but be required to maintain minimum balances subject to subordination. Id. at 54. This provides no choice for investors; floating NAV funds are available today, and investors who need the stability and liquidity of MMFs have rejected them.

19 The 2010 report warned that adopting a floating NAV would make MMFs a less desirable or even useless product for certain kinds of investors, the redemptions from which may cause deleterious and unintended consequences for a variety of users and credit markets as a whole. The report also said that the very shift to a floating NAV could cause major disruptions: MMFs are the dominant providers of some types of credit, such as commercial paper and short-term municipal debt, so a significant contraction of MMFs might cause particular difficulties for borrowers who rely on these instruments for financing. If the contraction were abrupt, redemptions might cause severe disruptions for MMFs, the markets for the instruments the funds hold, and borrowers who tap those markets. Report of the Presidents Working Group on Financial Markets: Money Market Fund Reform Options at 21 (Oct. 2010), http://www.treasury.gov/press-center/pressreleases/Documents/10.21%20PWG%20Report%20Final.pdf (PWG Report).

20 Release at 69467.

21 Id. at 69466.

22 Professor David W. Blackwell, Professor Kenneth R. Troske, and Professor Drew B. Winters, Money Market Funds Since the 2010 Regulatory Reforms: More Liquidity, Increased Transparency, and Lower Credit Risk at 44 (Fall 2012), http://www.uschamber.com/sites/default/files/reports/FinalpaperwithCover_smalltosend.pdf (tracking


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the burdens associated with the shift to a floating NAV, and the change itself is likely to bring about dislocations in short-term credit markets and the broader economy.

As discussed in more detail below, the Council should not propose that the SEC require a floating NAV for MMFs for the following reasons:







(7) A floating NAV, for the sake of showing minute variations in value that cancel out over time, would eliminate MMFs as a viable cash management tool by destroying their principal liquidity function.

(8) A floating NAV, for the sake of showing minute variations in value that cancel out over time, also would impose significant operational, accounting and tax burdens on users of MMFs and destroy their utility.

Footnote continued from previous page redemptions in the five largest MMFs by month for 2011). Letter from John D. Hawke, Jr. on behalf of Federated Investors to SEC (Feb. 24, 2012) (describing the various specialized uses of MMFs that require daily liquidity); Letter from John D. Hawke, Jr. on behalf of Federated Investors to SEC (Mar. 19, 2012) (supplying estimates of the amount of assets held for those specialized purposes).

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(9) A floating NAV would altogether prevent certain investors who are subject to statutory prohibitions and investment restrictions from using MMFs.

(10) A floating NAV, because of the operational burdens, costs, and other impediments, would substantially shrink the assets of MMFs.

(11) A floating NAV would therefore contract the market for, and raise the cost of, short-term public and private debt financing while potentially destabilizing those markets.

(12) A floating NAV would force current MMF users to less regulated and less transparent products.

(13) A floating NAV would accelerate the flow of assets to Too Big to Fail banks, further concentrating risk in that sector.

(14) The Councils proposal to rescind Rules 22e-3 and 17a-9 would remove important 2010 reforms designed to protect investors.

(15) Instead of focusing on the floating NAV, regulators should consider how MMFs enhanced liquidity has proved to be effective in absorbing heavy redemption requests, and how it has improved the characteristics of the marketplace from 2008.


As stated above, the Release acknowledges that a floating NAV for MMFs would not achieve the regulatory goal of eliminating a shareholders incentive to redeem in a crisis.23

Although the primary justification for moving to a floating NAV is to reduce the susceptibility of the funds to runs, the Council offers no empirical evidence to support this view. Indeed, the evidence suggests just the opposite, a point made in numerous letters in the SECs comment file, borne out in the experience of floating NAV funds during the crisis, and acknowledged by the

23 Release at 69467. See also FRBNY Staff Report at 54; Professor David W. Blackwell, Professor Kenneth R. Troske, and Professor Drew B. Winters, Money Market Funds Since the 2010 Regulatory Reforms: More Liquidity, Increased Transparency, and Lower Credit Risk (Fall 2012), http://www.uschamber.com/sites/default/files/reports/FinalpaperwithCover_smalltosend.pdf (citing recent scholarly papers on MMF regulation confirming that a floating NAV will not stop runs); Hal Scott, Interconnectedness and Contagion, Committee on Capital Markets Regulation at 224 (Nov. 20, 2012), http://www.capmktsreg.org/pdfs/2012.11.20_Interconnectedness_and_Contagion.pdf ( [A] floating NAV does not address the risk of contagion among MMMF investors.).

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Council in the Release.24 As Professors Jill Fisch, of the University of Pennsylvania Law School, and Eric Roiter, of the Boston University School of Law, have written:

Ultra-short bond funds are a near equivalent to money market funds but for the fact that they maintain a floating NAV. . . . While their share of assets pales in comparison to MMFs, ultra-short bond funds faced waves of redemptions comparable in respective magnitude to what MMFs faced. Indeed, contractions of ultra-short bond funds likely exacerbated the freeze in the short term credit markets. By the end of 2008, assets in these funds were 60% below their peak level in 2007. In Europe, both types of money market funds those with stable NAVs and those with floating NAVs have co-existed for years. Floating NAV money market funds suffered substantial redemptions during the credit crisis in 2008, leading more than a dozen of them to suspend redemptions temporarily and four of them to close altogether. French floating NAV money market funds lost about 40% of their assets during a three month period in the summer of 2007.25

Fidelity Investments also has pointed out the lack of empirical evidence to support the belief that in a period of market turmoil, funds with [Variable] NAVs would be at lower risk of significant redemptions from shareholders. In fact, during the financial crisis, VNAV funds in Europe experienced redemption pressures similar to [Constant] NAV funds.26

A recent paper by three finance and economics professors that surveyed recent scholarly papers on MMF regulation stated, All of the papers point out problems with the [floating] NAV proposal, and emphasized that MMFs reporting floating NAVs can still experience runs.27

24 See Letter from Invesco to IOSCO, filed with SEC (May 25, 2012); Letter from John D. Hawke, Jr. to Financial Stability Oversight Council (Dec. 15, 2011) (filed with the SEC); Letter from Fisch & Roiter to SEC (Dec. 2, 2011); Letter from Jacksonville Chamber to SEC (Jan. 31, 2011); Letter from Cincinnati Chamber to SEC (Jan. 13, 2011); Letter from ICI to SEC (Jan. 10, 2011); Letter from The Dreyfus Corporation to SEC (Jan. 10, 2011); Letter from Crane Data LLC to SEC (Jan. 10, 2011); Letter from Wells Fargo Funds Management to SEC (Jan. 10, 2011); Letter from T. Rowe Price to SEC (Jan. 10, 2011); Letter from Institutional Money Market Funds Association to SEC (Jan. 10, 2011); Letter from Vanguard to SEC (Jan. 10, 2011); Letter from Invesco Advisors to SEC (Jan. 10, 2011); Letter from SIFMA to SEC (Jan. 10, 2011); Letter from Fidelity to SEC (Jan. 10, 2011); Letter from European Fund and Asset Management Association to SEC (Jan. 10, 2011); Release at n.72 (acknowledging data submitted by commenters).

25 Letter from Fisch & Roiter to SEC (Dec. 2, 2011) (internal citations omitted). See also Letter from Institutional Money Market Funds Association to SEC (Jan. 10, 2011).

26 Letter from Fidelity Investments to IOSCO (May 30, 2012) (filed with the SEC) (citing Stephen Jank and Michael Wedow, Sturm und Drang in Money Market Funds: When Money Market Funds Cease to Be Narrow, Deutsche Bundesbank Discussion Paper, Series 2: Banking and Financial Studies, No. 20/2008).

27 Professor David W. Blackwell, Professor Kenneth R. Troske, and Professor Drew B. Winters, Money Market Funds Since the 2010 Regulatory Reforms: More Liquidity, Increased Transparency, and Lower Credit Risk (Fall 2012), http://www.uschamber.com/sites/default/files/reports/FinalpaperwithCover_smalltosend.pdf.

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As Professor Hal Scott further explained, requiring MMFs to adopt a floating NAV would not change the characteristics of the product itself: MMMFs would still provide the same degree of maturity and liquidity transformation. A floating NAV does not reduce the underlying risk of MMMF investments, including interest rate risk, credit risk and liquidity risk.28

One investment adviser warned that the shift to a floating NAV could precipitate a destabilizing flood of preemptive withdrawals by investors seeking to guarantee the return of their principal. This would bring about the very result that the measure was intended to prevent in the first place: a run on funds triggering a liquidity crisis and potentially destabilizing financial markets through widespread, forced sales of portfolio holdings.29 If investor confusion is a concern and investor protection is a regulatory goal, to promote the idea to investors that a floating NAV MMF is more safe and less run-prone is itself misleading.

Although the Council presumes to revive the regulatory process after the former SEC Chairmans unsuccessful attempt to garner sufficient votes for an SEC staff proposal to require, among other regulations, a floating NAV for MMFs, the Council, like the SEC, fails to offer any data to suggest that adopting a floating NAV would achieve the regulatory goal of reducing the risk of runs. The Council also fails to address the significant body of evidence to the contrary. As a result, the criticism of the SEC staffs proposal by SEC Commissioners Gallagher and Paredes applies equally to the Councils Release: [T]he necessary analysis has not been conducted to demonstrate that a floating NAV . . . would be effective in crisis.30 Further, the Commissioners pointed to the predominant incentive of investors in a crisis to flee risk and move to safety, stating,

As for the floating NAV proposal, even if there is no stable $1.00 NAV i.e., even if, by definition, there is no buck to break investors will still have an incentive to flee from risk during a crisis period such as 2008, because investors who redeem sooner rather than later during a period of financial distress will get out at a higher valuation.31

28 Hal Scott, Interconnectedness and Contagion, Committee on Capital Markets Regulation at 224 (Nov. 20, 2012), http://www.capmktsreg.org/pdfs/2012.11.20_Interconnectedness_and_Contagion.pdf.

29 Letter from Invesco Advisors to SEC (Jan. 10, 2011). Accord PWG Report at 22 (MMFs transition from stable to floating NAVs might itself be systemically risky. For example, if shareholders perceive a risk that a fund that is maintaining a $1 NAV under current rules has a market-based shadow NAV of less than $1, these investors may redeem shares preemptively to avoid potential losses when MMFs switch to floating NAVs. Shareholders who cannot tolerate floating NAVs probably also would redeem in advance. If large enough, redemptions could force some funds to sell assets and could make concerns about losses self-fulfilling.).

30 Daniel M. Gallagher and Troy A. Paredes, Commissioners, Securities and Exchange Commission, Statement on the Regulation of Money Market Funds (Aug. 28, 2012), http://www.sec.gov/news/speech/2012/spch082812dmgtap.htm.

31 Id.

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Even if the Council recommends that the SEC require MMFs to float their NAVs, the SEC will need to provide data concerning the benefits of such a change namely, whether the change would reduce the likelihood of MMF runs, versus the costs of such a change, including its impact on competition, efficiency, and capital formation. If the SEC does not support its predictive judgments with respect to the impact of a floating NAV, which to date it has been unable to do, it may find itself yet again on the losing end of another rule challenge.32


The Council in its Release relies heavily on a theory that MMFs are susceptible to a so-called first-mover advantage in which investors have an incentive to redeem their shares at the first indication of any perceived threat to an MMFs value or liquidity.33 This has happened only once in history, when the Reserve Fund failed to suspend redemptions after the bankruptcy of Lehman Brothers. According to the Release, Because MMFs lack any explicit capacity to absorb losses in their portfolio holdings without depressing the market-based value of their shares, even a small threat to an MMF can start a run. In effect, first movers have a free option to put their investment back to the fund by redeeming shares at the customary stable share price of $1.00, rather than at a price that reflects the reduced market value of the securities held by the MMF.34 Indeed, addressing the purported dangers associated with the first-mover advantage concept is a foundation of each of the three proposals in the Release. But the Councils armchair theorizing about a first-mover advantage is flatly contradicted by the recent report by the SECs Division of Risk, Strategy, and Financial Innovation (RiskFin Report), as well as the requirements of Rule 2a-7 itself, which the Council ignores.

As the RiskFin Report has pointed out, a funds amortized cost valuation closely tracks the funds shadow price.35 In many cases, the two are identical. In the absence of a credit event

32 Business Roundtable v. SEC, 647 F.3d 1144, 1149 (D.C. Cir. 2011).


34 Id. The Release also states that [r]ounding obscures the daily movements in the value of an MMFs portfolio and fosters an expectation that MMF share prices will not fluctuate. Importantly, rounding also exacerbates investors incentives to run when there is risk that prices will fluctuate. When an MMF that has experienced a small loss satisfies redemption requests at the rounded $1.00 share price, the fund effectively subsidizes these redemptions by concentrating the loss among the remaining shareholders. Id. at 69461.

35 Division of Risk, Strategy and Financial Innovation, Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher at 83 (Nov. 30, 2012), http://sec.gov/news/studies/2012/money-market-funds-memo2012.pdf. A funds shadow price is based upon market quotations for portfolio securities where they are available


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involving one or more of an MMFs assets (such as a downgrade or default) which would disrupt this close tracking, there is simply not enough of variation between the amortized cost NAV and the funds shadow price to create the incentive the Council now claims exists.

Moreover, Rule 2a-7 places a number of detailed remedial obligations on the board of an MMF whenever a credit event occurs. These obligations are designed to prevent the first-mover advantage from developing. In the event that a portfolio security is downgraded, Rule 2a-7 requires an MMFs board to reassess promptly whether such security continues to present minimal credit risks and [to] cause the fund to take such action as the board of directors determines is in the best interests of the money market fund and its shareholders unless the fund is able to dispose of the security (or is matures) within five days of the event.36 In the event of a default, the fund must dispose of the security as soon as practicable consistent with achieving an orderly disposition unless the board finds that disposal would not be in the best interest of the fund.37 Rule 2a-7 also requires prompt notice to the SEC if securities accounting for 1/2 of 1 percent or more of an MMFs total assets default (other than an immaterial default unrelated to the issuers financial condition) or the securities become subject to certain events of insolvency.38 In its notice, the board must state the actions the MMF intends to take in response to such event.

An MMF is only permitted to price its shares at $1.00 using the amortized cost method so long as the board of directors believes that it fairly reflects the market-based net asset value per share.39 If the board believes any deviation from MMFs amortized cost price per share may result in material dilution or other unfair results to investors or existing shareholders, the board is required to cause the fund to take action to eliminate or reduce the effect of the dilution or unfair results.40 Further, Rule 2a-7 provides that in the event that the extent of an MMFs deviation from the mark-to-market NAV exceeds of 1 percent, the board must promptly consider what action, if any, should be initiated . . . .41 In other words, in the event of a material credit event involving one or more of its portfolio securities, the fund would be required to go off amortized cost for the affected portfolio securities and value its shares based on the current NAV (as defined under SEC rules) as other mutual funds do. If immediate recognition of the credit

Footnote continued from previous page and fair valuation of portfolio instruments where market quotations are not available. This is discussed in greater detail in section 5 of this paper.

36 15 C.F.R. 270.2a-7(c)(7)(i)(A).

37 15 C.F.R. 270.2a-7(c)(7)(ii).

38 15 C.F.R. 270.2a-7(c)(7)(iii).

39 15 C.F.R. 270.2a-7(c)(1).

40 15 C.F.R. 270.2a-7(c)(8)(ii)(C).

41 15 C.F.R. 270.2a-7(c)(8)(ii)(B).

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problem causes the MMF to break the buck, a redeeming shareholder would receive the current NAV for each share redeemed, rather than $1.00. That shareholder would not be receiving the benefit of $1.00 per share by redeeming before other shareholders. Unless the fund board and its pricing service fail to do their jobs in pricing fund shares, there is no first-mover advantage.

In addition to the above requirements, Rule 22e-3 currently gives an MMF board significant authority to intervene to protect investors, by suspending redemptions and beginning an orderly liquidation if an MMF has broken or is about to break the buck.42 The rule, adopted as part of the SECs 2010 reforms, is designed to prevent investor panic and prevent the type of run that could potentially reward first movers, by assuring that the board has the authority to suspend redemptions in order to treat all investors fairly in a liquidation. The rule is designed to address the potential for runs regardless of their cause whether liquidity-driven (such as the 2008 crisis),43 credit-driven, or interest-rate driven. The Council, however, proposes to rescind Rule 22e-3, rationalizing that a floating NAV diminishes the need for MMF sponsors or boards to suspend redemptions or otherwise intervene upon share price declines except under the most extreme market circumstances.44 But, as discussed earlier in this paper, the Council itself admits that a floating NAV would fail to remove the risk of runs in a crisis; experts and experience from the past financial crisis confirm this as well. Thus, the Release not only ignores and fails to acknowledge the multitude of SEC requirements designed to assure that MMF boards take appropriate action to treat all investors equally and fairly, it recommends rescinding a key 2010 reform that addresses exactly the type of run risk the Council states it wishes to prevent.


It has been suggested that the use of a stable NAV creates an opportunity for shareholders to profit through arbitrage of the difference between the shadow NAV and $1.00 per share price. There is no way to profit, however, from purchasing MMF shares at $1.00 per share and redeeming at $1.00 per share. MMF shares are not offered for sale at below $1.00 per share. There is no opportunity to buy below $1.00 per share and sell at a higher price. There is no market for short-selling MMF shares. Indeed, there is no secondary market for sales of MMF at all they can only be disposed of by redeeming the shares from the MMF, and the price is the funds NAV.

42 17 C.F.R. 270.22e-3.

43 Of course, in addition to an MMF boards authority to suspend redemptions in the event of a liquidity-driven crisis, the SECs 2010 amendments focused extensively on enhancing the resiliency of MMFs by strengthening the liquidity of MMF portfolios. Rule 2a-7s liquidity requirements are discussed in detail in Section 15 of this paper.

44 Release at 69466. Of course, an MMF could still seek an order from the SEC permitting the fund to suspend redemptions and liquidate.

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At most, under the theories espoused in the Release, an investor in an MMF might in rare cases avoid a potential loss on the investment by getting out ahead of other investors before a price decline. In the past, MMF shareholders would have had only two chances to have profited by avoiding a loss on MMF shares. The first such instance was in connection with the closure of the Community Bankers U.S. Government Fund, which in 1994 repaid its investors 96 cents on the dollar. The second was the Reserve Primary Fund, which was forced to liquidate in September 2008 as a result of a run triggered by Lehmans bankruptcy and the funds holdings of Lehman commercial paper. The Reserve Primary Fund has returned to shareholders more than 99 cents on the dollar. In order to have gained the benefit from these events, MMF shareholders would have had to invest in several hundred MMFs over a period of forty years. Moreover, the profit from those transaction would not have been making money, but avoiding a loss of nine tenths of one cent per share in one case, and four cents per share in the other. It is hard to understand what would motivate an investor to purchase shares in an MMF to seek out this arbitrage opportunity to, at best, not lose money.

Thus, the proposition that an investor could profit from arbitraging a stable value MMF, when the investor transacts in and out of the fund at one dollar per share, is meritless. Given that many MMFs are now voluntarily publishing their shadow prices on a daily basis, the SEC will have the opportunity to assess this theoretical arbitrage possibility.


If requiring MMFs to adopt a floating NAV will not achieve its regulatory purpose and may even precipitate runs, what then is the point of requiring a floating NAV in the first instance? The Release suggests that the goal may be to remove uncertainty as to who bears the risk of loss in an MMF. According to the Release, MMF investors have the perception that shareholders do not bear any risk of loss when they invest in an MMF.45 Requiring a floating NAV would make gains and losses on MMF investments a regular occurrence, would accustom investors to changes in the value of their MMF shares, and would reinforce the principle that investors, not fund sponsors or taxpayers, are expected to bear the pro rata risk of loss in MMFs, as they do with other investment vehicles.46 The Release further suggests that although MMF prospectuses are required to disclose to investors that their shares may lose value, past support by fund sponsors may have obscured some investors appreciation of MMF risks

45 Id.

46 Id. at 69466-67.

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and caused some investors to assume that MMF sponsors will absorb any losses, even though sponsors are under no obligation to do so.47

The Releases commentary on the misperceptions of investors follows former SEC Chairman Schapiros numerous statements to the same effect. Former Chairman Schapiro stated that MMF investors dont appreciate that these are investments, these are not cash instruments, theyre investments and when they break the buck, the impetus to run is enormous.48 She said that a floating NAV would reinforce what money market funds are an investment product49

and would cause shareholders to become accustomed to fluctuations in the funds share prices, and thus less likely to redeem en masse if they fear a loss is imminent, as they do today.50 She further commented, The stable $1.00 share price has fostered an expectation of safety, although money market funds are subject to credit, interest-rate and liquidity risk. . . . As a result, when a fund breaks the dollar, investors lose confidence and rush to redeem.51

To be clear, not only are MMFs uninsured, Congress in 2009 specifically prohibited the Department of the Treasury from using the Exchange Stabilization Fund to support a program to guarantee MMF shareholders, as it did in the financial crisis in 2008.52 MMF investors neither rely upon a government guarantee nor do they seek it. Indeed, perhaps the strongest evidence of this fact is that in the midst of the financial crisis, MMF investors poured a net $170 billion in uninsured investments back into prime MMFs at the end of 2008.53 At that time, it was

47 Id. at 69462.

48 Oversight of the Securities and Exchange Commission: Hearing Before the Subcomm. on Capital Markets and Government Sponsored Enterprises of the H. Comm. on Financial Services (Apr. 25, 2012) (archive of hearing webcast), http://financialservices.house.gov/Calendar/EventSingle.aspx?EventID=290689.

49 Chairman Mary L. Schapiro, Remarks at SIFMAs 2011 Annual Meeting (Nov. 7, 2011).

50 Perspectives on Money Market Mutual Fund Reforms: Hearing Before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, 112th Cong. 12 (Jun. 21, 2012) (Testimony of Chairman Mary L. Schapiro), http://banking.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=bba4146c-6b7f-47d093bc-ebc73189c9c0. See also Chairman Mary L. Schapiro, Remarks at the Society of American Business Editors and Writers Annual Convention (Mar. 15, 2012) (A floating NAV would desensitize investors to the occasional drop in value of MMFs.).

51 Perspectives on Money Market Mutual Fund Reforms: Hearing Before the U.S. Senate Comm. on Banking, Housing, and Urban Affairs, 112th Cong. 10 (Jun. 21, 2012) (Testimony of Chairman Mary L. Schapiro), http://banking.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=bba4146c-6b7f-47d093bc-ebc73189c9c0.

52 Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, 131(b), 122 Stat. 3765, 3797-98 (2008) (The Secretary is prohibited from using the Exchange Stabilization Fund for the establishment of any future guaranty programs for the United States money market mutual fund industry.).

53 Treasury Strategies, Dissecting the Financial Collapse of 2007-2009 at 3, http://www.sec.gov/comments/4619/4619-188.pdf (filed as a comment letter with the SEC June 1, 2012); Press Release, Treasury Announces Guaranty Program for Money Market Funds (Sept. 19, 2008), http://www.treasury.gov/press-center/pressreleases/Pages/hp1147.aspx.

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abundantly clear to investors that an MMF could break the buck. It was also clear that MMF shares purchased after September 19, 2008 were not covered by the Treasury guarantee program.

As discussed below, institutional investors are clearly aware of the risks of investing in MMFs, and, according to surveys of retail investors, the vast majority of these users also are well aware of these risks.54 The Release offers no data to support its statements that investors may be confused or uncertain regarding the nature of MMFs, and offers no rebuttal to the survey data and individual letters that fill the SECs comment file stating the opposite.

Its not appropriate for regulators to treat investors like children. In a hearing before the Senate Committee on Banking, Housing, and Urban Affairs, the Treasurer of the State of Maryland responded to former Chairman Schapiro:

[O]n behalf of many of the investors . . . [w]e do read the prospectus and we know its an investment. Its not a savings account. And the reforms of 2010 and the experience of 2008 I think has brought that home very clearly. So I think this treating us sort of like children is really not appropriate.55

The National Association of State and Local Treasurers made similar comments in a letter filed with the SEC, stating that it does not accept the statement that investors believe that money market funds are risk free cash equivalents. On the contrary, NAST believes that investors realize that money market funds have an inherent risk, albeit a small one.56 An investor, in a comment letter to the SEC, stated, I think you underestimate American's abilities to comprehend the investment risks that they're taking. And those of us that do understand the risks should not have to suffer poorer investments options . . . .57 These views are borne out in surveys of retail investors. For example, Fidelity Investments, after conducting a survey of its retail customers, reported that 75% of retail investors surveyed understood that MMFs are not guaranteed by a government entity. Only 11% of those surveyed believed MMF were guaranteed, while 14% were unsure.58

54 Letter from Fidelity Investments to SEC (Feb. 3, 2012) (citing survey data of retail and institutional investors).

55 Oversight of the Securities and Exchange Commission: Hearing Before the Subcomm. on Capital Markets and Government Sponsored Enterprises of the H. Comm. on Financial Services (Apr. 25, 2012) (archive of hearing webcast), http://financialservices.house.gov/Calendar/EventSingle.aspx?EventID=290689 (Testimony of Maryland State Treasurer Nancy Kopp in response to questions posed by Senator Toomey).

56 Letter from National Association of State and Local Treasurers to SEC (Dec. 21, 2010) (internal citations omitted).

57 Letter from Scott OReilly to SEC (Aug. 16, 2012).

58 Letter from Fidelity Investments to SEC (Feb. 3, 2012).

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In addition to surveys of retail investors, which tell us a great deal, the vast majority of MMF investors are institutional investors, and it simply is not credible to assert they do not understand the nature of MMFs, including the nature of sponsor support. MMFs clearly disclose that they are Not FDIC Insured and May Lose Value.59 The variable shadow price of each MMF and each individual instrument in the fund is reported monthly to the SEC, which makes it publicly available on its website, clearly reflecting the fluctuations (however minute) in the underlying valuation of each MMF.60

Neither the Council in its Release nor the SEC has provided survey or other data supporting the view that investors believe there is implicit support for MMFs or that they are unaware of the small fluctuations in underlying market value of MMF shares. Moreover, while taking the position that investors may misperceive the risks of MMFs, the Council fails to address the results of Fidelitys extensive survey of retail investors demonstrating that a large majority of retail investors understand that MMFs are unguaranteed investment products. Oddly, the Release cites that very survey for other purposes in the Release.61 Without data of their own, and without responding to evidence to the contrary, the Councils and the SECs statements regarding investor perceptions are mere speculation.62


In its Release, the Council states that after requiring MMFs to adopt a floating NAV the value of MMFs shares would reflect the market value of the underlying portfolio holdings, consistent with the valuation requirements that apply to all other mutual funds under the Investment Company Act.63 The Release echoes earlier statements to the same effect by former Chairman Schapiro64 and Treasury Secretary Timothy Geithner.65 These statements suggest a

59 15 U.S.C. 80a-34. See also 17 C.F.R. 270.34b1; 17 C.F.R. 230.482 (requiring all MMF advertisements to include the following statement: An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.).

60 MMFs, in turn, provide links from their websites to the portfolio information presented on the SECs website.

61 Release at n.80.

62 Business Roundtable v. SEC, 647 F.3d 1144, 1150 (D.C. Cir. 2011).


64 In a statement last year, former Chairman Schapiro argued that MMFs should float the NAV and use mark-tomarket valuation like every other mutual fund. Mary Schapiro, Chairman, Securities and Exchange Commission, Statement on Money Market Fund Reform (Aug. 22, 2012), http://www.sec.gov/news/press/2012/2012-166.htm.

65 In his letter of September 27, Treasury Secretary Timothy Geithner argued that a floating NAV would allow the value of investors shares to track more closely the values of the underlying instruments held by MMFs and eliminate the significance of share price variation in the future. Letter from Timothy F. Geithner, Secretary of the


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view among regulators that, if MMFs redeemed shareholders securities at a floating or variable NAV, that price would be a truer indication of the MMFs mark-to-market value.

The Myth of Marking-to-Market to Arrive at a Floating NAV. What is left out of these statements by regulators perhaps because they may not be familiar with the nature of the instruments held in MMF portfolios is that there are no daily reported prices for many of the instruments held in a prime MMF portfolio.66 Because of their short-term nature, money market instruments generally are purchased and held to maturity (which is the general basis under GAAP67 for the use of amortized cost accounting used by MMFs to value portfolio assets). In a lengthy analysis of the performance of stable and floating NAV funds, Professors Fisch and Roiter point out that [v]ery short-term money market instruments like commercial paper or bank CDs ordinarily lack readily available market prices.68

Commercial paper and other instruments for which there are no readily available market prices are priced based on their fair valuation a reasonable estimate of the price at which the instrument could be sold in a current trade. Thus, these valuations are not necessarily mark-tomarket prices. An MMFs board, like the board of any mutual fund, in valuing the funds portfolio assets, must use the market value for securities or other assets for which market quotations are readily available, and with respect to other securities and assets, must use their fair value as determined in good faith by the board of directors.69 As Professors Fisch and Roiter point out, the SEC has provided extensive guidance on the issue.70 But the SEC also has long acknowledged that there is no single correct fair value and, that The same security held in the portfolios of different funds can be given different fair value prices at any one time, all of which can be reasonable estimates meeting the statutory standard.71

In practice, MMFs have elaborate and rigorous procedures to obtain valuations for their portfolio assets and to measure deviations between the MMFs amortized cost price per share

Footnote continued from previous page Treasury, to Members of the Financial Stability Oversight Council (Sept. 27, 2012), http://www.treasury.gov/connect/blog/Documents/SEC.Geithner.Letter.To.FSOC.pdf. 66 Of course, for government MMFs, there are ample market prices for Treasuries and agency securities.

67 Accounting for Certain Investments in Debt and Equity Securities, Statement of Fin. Accounting Standards No. 115, 7 (Fin. Accounting Standards Bd. 1993). See also the discussion of amortized cost as applied to MMFs in Professor Dennis R. Beresford, Amortized Cost is Fair for Money Market Funds (Fall 2012), http://www.centerforcapitalmarkets.com/wp-content/uploads/2010/04/Money-Market-Funds_FINAL.layout.pdf.

68 Letter from Fisch & Roiter to SEC at 7 (Dec. 2, 2011).

69 17 C.F.R. 270.2a-4.

70 Letter from Fisch & Roiter to SEC at n.22-23 (Dec. 2, 2011).

71 Id. at 6.

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and the current net asset value per share calculated using available market quotations (or an appropriate substitute that reflects current market conditions).72 SEC rules require that they do this. Virtually all MMFs engage independent pricing services to get to a high degree of comfort that the valuations identified by these services for each instrument held in portfolio appropriately reflects current market conditions, and MMF internal valuation experts closely monitor any deviations from the valuations obtained using amortized cost accounting. Where there are variations, depending upon internal thresholds that may be reached, MMF procedures generally require involvement of internal valuation committees and in some circumstances the board.

But, these pricing services normally do not identify mark-to-market prices, due to the fact that many of the instruments held in a prime MMF portfolio do not have reported trading prices on any given day. For those instruments that do not trade on a daily basis, these services generally use what is known as matrix pricing: the pricing service compares each individual instrument within the portfolio to a homogenous set of instruments in the market (e.g., because they have similar ratings, interest rates, maturities) and derives a valuation that it believes reflects current market conditions based upon similar instruments that have traded that day.73

While matrix pricing is mechanistic and may be an appropriate substitute where there is no mark-to-market price, different pricing services may arrive at very minute differences in prices for a portfolio asset, depending upon how they bucket it and the market prices used as reference points. Moreover, each MMF board has the ultimate responsibility to assure that valuation methods used (whether by a pricing service or otherwise) are appropriate. It is this valuation method that MMFs use to arrive at a shadow price to compare against the amortized cost valuations.74 It is an important benchmark, but it is, like amortized cost valuation, a type of fair valuation and is not mark-to-market.75 Indeed, as discussed further below, because the valuations derived under this method are often identical to, or very similar to, valuations derived using amortized cost, amortized cost is a more efficient and reliable means of pricing MMF portfolio assets.

72 17 C.F.R. 270.2a-7(c)(8)(ii)(A).

73 Fair Value Measurement, Accounting Standards Update Topic 820-10-55-3C (Fin. Accounting Standards Bd. May 2011) (Matrix pricing is a mathematical technique used principally to value some types of financial instruments, such as debt securities, without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities relationship to other benchmark quoted securities.).

74 These calculations and comparisons are done periodically as determined by the funds board of directors, generally weekly if required by rating agencies, or every two weeks. Calculations should be more frequent in volatile market conditions.

75 The same general approach has been adopted by the Financial Industry Regulatory Authority (FINRA), and approved by the SEC, as the standard for broker-dealers to price debt securities when there is no active trading market. FINRA Rule IM-2440-2; Securities Exchange Act Release No. 55638 (Apr. 16, 2007), 77 Fed. Reg. 20150 (April 23, 2007).

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A Distinction Without a Difference. Day to day, the shadow price of an MMF however it is determined deviates from the $1.00 per share arrived at through amortized cost accounting by only miniscule amounts, if at all. The Investment Company Institute (ICI), has produced several studies detailing this point. According to its analysis of MMF prices maintained even prior to the 2010 reforms, Data from a sample of taxable money market funds covering one-quarter of U.S. taxable money market fund assets show that the average per-share market values for prime money market funds varied between $1.002 and $0.998 during the decade from 2000 to 2010.76

An analysis of more recent data submitted by the ICI to Congress demonstrates that the remarkable stability of MMF prices has continued under the 2010 reforms:

[U]sing publicly available data from Form N-MFP reports that require money market funds to disclose their underlying mark-to-market share price, without using amortized cost pricing, ICI calculated changes in prime fund share prices on a monthly basis for January 2011 to March 2012. Nearly all (96 percent) of the prime money market funds had an average absolute monthly change in their mark-to-market share prices of 1 basis point [(one hundredth of one penny per share)] or less and all had an average absolute monthly change of less than 2 basis points.77

As these data demonstrate, the stable NAV using amortized cost closely tracks the shadow price (the floating value) using other methods of valuation. They are usually identical (even before rounding the NAV to the nearest cent) and only occasionally deviate from one another by plus or minus a few one-hundredths of a cent.78 To put this in perspective, a deviation of a hundredth of one percent is equal to $.10 on a thousand dollars worth of MMF shares. Unless the MMF is suddenly liquidated, even that small price deviation is not translated into actual losses, because the underlying portfolio investments mature in short order and are repaid at par, which returns the shadow price to $1 per share. Due to the very high levels of liquid assets that MMFs are required to hold under amended Rule 2a-7, it is now even less likely that an MMF would need to sell portfolio assets before maturity to raise cash and recover less than par value. The enhanced liquidity requirements of amended Rule 2a-7 further support the

76 Letter from ICI to SEC (Feb. 16, 2012).

77 Perspectives on Money Market Mutual Fund Reform: Hearing Before the U.S. Senate Committee on Banking, Housing and Urban Affairs, 112th Cong. at 29-30 (Jun. 21, 2012) (testimony of Paul Schott Stevens, President, Investment Company Institute), http://banking.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=bba4146c-6b7f-47d093bc-ebc73189c9c0) (citing the publicly available data from the Form N-MFPs MMFs are required to file each month with the SEC).

78 ICI Research Report, Pricing of U.S. Money Market Funds (Jan. 2011).

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economic validity of using amortized cost they ensure that absent a credit event, no firstmover advantage will materialize.

At least two financial regulators represented on the Council recently have published statements acknowledging the effectiveness of amortized cost in tracking the shadow price using other methods of valuation. First, in the RiskFin Report the SEC staff analyzed the distribution of MMF shadow prices between 1994 and 2012 based on data from N-SAR filings. Except for two brief periods, Figure 16 of the Divisions report shows 95% of MMFs continuously maintained shadow NAVs of $0.999 or greater. The two exceptions are the first half of 1994, when the Federal Reserve unexpectedly implemented a series of significant interest rate hikes, and the height of the financial crisis in September 2008. Neither of these events caused the shadow NAVs of these funds to fall below $0.998.79

Second, when permitting bank short-term investment funds to use amortized cost accounting and round share prices to nearest cent, the Comptroller of the Currency concluded, [B]ecause . . . investments are limited to shorter-term assets and those assets generally are held to maturity, differences between the amortized cost and mark-to-market value of the assets will be rare, absent atypical market conditions or an impaired asset.80


In its Release, the Council suggests that its proposal to require MMFs to float their NAVs and mark portfolio assets to market is consistent with the requirements that apply to all other mutual funds.81 But the Council also recommends that MMFs re-price their shares to an initial $100.00 per share to be more sensitive to fluctuations in the value of the portfolios underlying securities than under a $1.00 per share price.82 The latter is certainly not consistent with the requirements that apply to other mutual funds.83 In fact, no current law or regulation requires an investment company under the Investment Company Act of 1940 to offer its shares at a

79 Division of Risk, Strategy and Financial Innovation, Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher at 27-28 (Nov. 30, 2012), http://sec.gov/news/studies/2012/money-market-funds-memo2012.pdf.

80 Short-Term Investment Funds, 77 Fed. Reg. 61230 (Oct. 9, 2012) (to be codified at 12 C.F.R. Part 9).


82 Id.

83 This issue is discussed extensively in letter from Stephen Keen to the Council. Letter from Stephen A. Keen to the Financial Stability Oversight Council (Nov. 26, 2012), http://www.regulations.gov/#!documentDetail;D=FSOC2012-0003-0004.

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particular price. Other investment companies that value their shares their shares at $10.00 do so by market custom, not as required by law or regulation. Rather, removing the pricing exemption provided by Rule 2a-7 would require MMFs to comply with Accounting Series Release No. 219, which states only that MMFs must calculate current net asset value per share with an accuracy of one-tenth of one percent . . . .84

Although stating in its Release that its proposal would require MMFs to price shares in the same way other mutual funds do, the Council is in fact holding MMFs to an arbitrarily more stringent pricing standard than other types of funds. In fact, MMF shares fluctuate so little that the Council has had to concoct an abnormally high $100.00 share price in order to show movement in the NAVs of the funds. To what end? What purpose is served, given that investors are already aware of the potential for fluctuations in MMFs underlying NAVs? The only result of this arbitrary requirement would be to drive investors to alternative cash management products that are not burdened with an arbitrary pricing standard and do not impose on investors the tax, accounting, and operational burdens described below.

(7) A Floating NAV, for the sake of showing minute variations in value that cancel out over time, would eliminate MMFs as a viable cash management tool by destroying their principal liquidity function.

Nearly every commenter who filed a letter with the SEC opposing the floating NAV wrote that forcing MMFs to abandon the stable NAV would eliminate the MMF as a viable cash management tool by destroying its principal liquidity function. These commenters include both users and issuers, state and local government officials, local and regional chambers of commerce, asset managers, and the industry groups that represent them. Many users, both institutional and individual, stated that MMFs, because of their stable NAV feature, are essential to their cash management strategies.85

84 Valuation of Debt Instruments by Money Market Funds and Certain Other Open-End Investment Companies, Investment Company Act Release No. 9786, 42 Fed. Reg. 28999, 29001 (June 7, 1977).

85 Letter from David Daniel to SEC (Aug. 21, 2012); Letter from Rick Fetterman to SEC (Aug. 15, 2012); Letter from Joe McNamara to SEC (Aug. 14, 2012); Letter from Rudy Mueller to SEC (Aug. 14, 2012); Letter from Hal Goldberg to SEC (Aug. 14, 2012); Letter from Denver Metro Chamber to SEC (July 20, 2012); Letter from Louisiana Retailers Association to SEC (July 19, 2012); Letter from Utah Association of Counties to SEC (Jun. 27, 2012); Letter from North Carolina Independent Colleges and Universities to SEC (Apr. 13, 2012); Letter from Association for Financial Professionals, Benefit Resource, Inc., Blue Cross Blue Shield of Massachusetts, CacheMatrix, Catholic Health Initiatives, California ISO, CareSource, Centerline Capital Group, Crawford & Company, Grass Valley USA LLC, Miami-Dade County Public Schools, Solix, Inc., University of Colorado Treasurers Office, and WellCare Health Plans, Inc. to SEC (Apr. 4, 2012) (Letter from Association for Financial Professionals and 13 other organizations); Letter from Indiana Chamber to SEC (Mar. 20, 2012); Letters from American Public Power Association, Council of Development Finance Agencies, Council of Infrastructure Financing Authorities, Government Finance Officers Association, International City/County Management Association, International Municipal Lawyers Association, National Association of Counties, National Association


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As a group of 14 local, state, and national public agency associations explained, MMFs are a popular cash management tool because they are highly regulated, have minimal risk, and are easily booked.86 While similarly extolling the benefits of stable NAV funds, the New Hampshire College & University Council warned of the adverse consequences of requiring MMFs to shift to a floating NAV:

These funds have consistently proven to be a safe, efficient, and effective cash management tool. Requiring a floating NAV would have negative implications for the utilization of money market mutual funds, as investors would be forced to seek alternative products that are less regulated and provide less diversification. To that end, we are concerned a floating NAV would effectively eliminate money market mutual funds as a viable investment tool for public and private higher education institutions.87

Footnote continued from previous page of Health and Educational Facilities Finance Authorities, National Association of Local Housing Financing Agencies, National Association of State Auditors, Comptrollers and Treasurers, National Association of State Treasurers, National Council of State Housing Agencies, National League of Cities, U.S. Conference of Mayors to SEC (Mar. 8, 2012) (14 National, State and Local Entities); Letter from Greater Raleigh Chamber to SEC (Feb. 28, 2012 and Jan. 31, 2011); Letter from Bob Maddox to SEC (Feb. 7, 2012); Letter from New Hampshire College & University Council to SEC (Jan. 12, 2012); Letter from Washington State Treasurer to SEC (Nov. 15, 2011); Letter from New Jersey Association of Counties (Jul. 11, 2011); Letter from Greater Albuquerque Chamber of Commerce to SEC (Feb. 7, 2011); Letter from Florida Department of Financial Services to SEC (Feb. 3, 2011); Letter from Jacksonville Chamber to SEC (Jan. 31, 2011); Letter from Association of Commerce and Industry, New Mexico to SEC (Jan. 31, 2011); Letter from Providence Chamber of Commerce to SEC (Jan. 31, 2011); Letter from Greater Durham Chamber of Commerce to SEC (Jan. 31, 2011); Letter from New Mexico Association of Counties to SEC (Jan. 28, 2011); Letter from Florida Chamber of Commerce to SEC (Jan. 28, 2011); Letter from North Carolina Chamber of Commerce to SEC (Jan. 25, 2011); Letter from American Association of State Colleges and Universities to SEC (Jan. 21, 2011); Letter from Texas Municipal League to SEC (Jan. 21, 2011); Letter from Utah State Treasurer to SEC (Jan. 20, 2011); Letter from New Jersey Chamber of Commerce to SEC (Jan. 18, 2011); Letter from Northern Rhode Island Chamber of Commerce to SEC (Jan. 15, 2011); Letter from the Mayor of Salt Lake City, Utah to SEC (Jan. 13, 2011); Letter from National Association of State and Local Treasurers to SEC (Dec. 21, 2010). See also Letter from Independent Directors Council & Mutual Fund Directors Forum to SEC (May 2, 2012); Letters from John D. Hawke, Jr. on behalf of Federated Investors (Mar. 19, 2012 and Dec. 15, 2011); Letter from SunGard Global Network to SEC (Mar. 16, 2012); Letter from DST Systems to SEC (Mar. 2, 2012); Letter from Cachematrix to SEC (Dec. 12, 2011); Letter from Fisch & Roiter to SEC (Dec. 2, 2011); Letter from Cachematrix to SEC (Apr. 29, 2011). See also Letter from 2254 individuals to SEC (Various dates).

86 Letter from American Public Power Association, Council of Development Finance Agencies, Council of Infrastructure Financing Authorities, Government Finance Officers Association, International City/County Management Association, International Municipal Lawyers Association, National Association of Counties, National Association of Health and Educational Facilities Finance Authorities, National Association of Local Housing Financing Agencies, National Association of State Auditors, Comptrollers and Treasurers, National Association of State Treasurers, National Council of State Housing Agencies, National League of Cities, U.S. Conference of Mayors to SEC (Mar. 8, 2012).

87 Letter from New Hampshire College & University Council to SEC (Jan. 12, 2012).

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The Council in its Release acknowledges that a wide range of entities use MMFs for a variety of cash management and investment purposes, and that certain types of users may be unwilling or unable to conduct their cash management through an investment vehicle that does not offer a stable value.88 The Council states that removing the stable NAV of MMFs would be a significant change for a multi-trillion dollar industry in which the stable $1.00 share price has been a core feature that may reduce overall investor demand for MMFs, which would diminish the funds capacity to invest in the short-term securities of financial institutions, businesses, and governments, possibly impacting their costs of funding. But, the Release simply claims the ultimate long-term reaction to such a change is difficult to predict with any precision.89 It then declines to make any attempt to size the impact of eliminating MMFs as a cash management tool on the MMF users or long-term economic growth.

(8) A Floating NAV, for the sake of showing minute variations in value that cancel out over time, also would impose significant operational, accounting and tax burdens on users of MMFs and destroy their utility.

Although the Release acknowledges certain operational costs, accounting impacts, and tax considerations associated with requiring MMFs to adopt a floating NAV, the Council does so with little analysis and does not attempt to size their impact on users.90 Further, the Council does not address the potential consequences of the migration of assets away from MMFs once they no longer exhibit the key features of operational, tax and accounting simplicity and efficiency. Given that these changes will make MMFs a substantially less attractive and more cumbersome product compared to other cash management alternatives, a shift of assets away from MMFs and into other cash management products is a likely outcome of the Councils proposal.91 The Councils failure to address these consequences in the Release is a significant oversight.

88 Release at 69457, 69468.

89 Id. at 69468.

90 Id. at 69467-68.

91 Letter from Jonathan R. Macey to Financial Stability Oversight Council (Nov. 27, 2012), http://www.regulations.gov/#!documentDetail;D=FSOC-2012-0003-0010 (A stable $1.00 NAV provides convenience and simplicity to investors and managers alike, boosting MMFs efficiency with regard to tax, accounting, and recordkeeping. Unlike other mutual funds, MMFs are used primarily as a cash management tool, which means that large transactions flow through them every day. Without a stable NAV, many investors will bolt for other cash management entities in order to minimize tax, accounting, and recordkeeping burdens.) (Macey 2012).

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Users would lose key operational features only available with a stable NAV fund. A number of features MMFs currently offer would not be possible with a floating NAV. As the investment advisor Invesco stated, a stable share price simplifies cash management policies for investors and has made it possible for broker-dealers to make available to clients a wide range of features including ATM access, check writing, and ACH and Fedwire transfers. These features are generally provided only for accounts with a stable NAV.92 For example, according to ICI, MMFs typically offer retail investors same-day settlement on shares redeemed via wire transfers (where redemption proceeds are wired to an investors bank account via fedwire), whereas bond funds typically offer only next day settlement for wire transfers.93

If MMFs are required to float their NAV, all of these systems would have to undergo significant retooling of accounting, trading, and settlement systems to accommodate the possibility of a minute change in a funds NAV. That cost, according to many commenters, would be substantial.94 Cachematrix, a software provider of online institutional trading systems for banks and financial institutions, stated,

[A]n entire industry has programmed accounting, trading and settlement systems based on a stable share price. The cost for each bank to retool their sub-accounting systems to accommodate a fluctuating NAV could be in the millions of dollars. This does not take into account the costs that each bank would then pass on to the thousands of corporations that use money market trading systems.95

As an example, the stable share price of MMFs currently simplifies corporate treasury operations. Treasurers know the $1.00 NAV in advance, and, as Vanguard pointed out, that amount often is hard-coded into companies accounting and cash-tracking systems. Treasurers can then use an MMF to fund transactions over the course of the day.96 Bank sweep account systems with an option to invest in MMFs often do the same.97 As the American Bankers Association described the effect of the floating NAV on these operations,

92 Letter from Invesco to SEC (Sept. 4, 2009).

93 Letter from ICI to SEC (May 25, 2012).

94 Letter from Louisiana Retailers Association to SEC (July 19, 2012); Letter from Allegheny Conference and Greater Pittsburgh Chamber to SEC (Apr. 24, 2012); Letter from Association for Financial Professionals and 13 other organizations to SEC (Apr. 4, 2012); Letter from John D. Hawke, Jr. to SEC (Mar. 19, 2012); Letter from ICI to SEC (Feb. 16, 2012); Letter from Cachematrix to SEC (Dec. 12, 2011); Letter from Invesco to SEC (Sept. 4, 2009).

95 Letter from Cachematrix to SEC (Dec. 12, 2011).

96 Letter from Vanguard to SEC (Jan. 10, 2011). See also Money Market Working Group, Investment Company Institute, Report of the Money Market Working Group at 109-10 (Mar. 17, 2009), http://www.ici.org/pdf/ppr_09_mmwg.pdf.

97 Id.

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If the NAV floats, service providers would need to request that shares be redeemed prior to the close of the market (when the fund is priced), but the number of shares needed to be redeemed to fund the transaction would be uncertain. Estimating the number of shares needed to be redeemed will result in an end-of-day excess or shortfall. This leads to a potentially significant difficulty in calculating the end-of-day values. By contrast, a stable NAV provides certainty for funding the days transactions. Similarly, municipal bond issuers who, under their indentures, are required to maintain reserves at a specified level can be assured that they will not have to advance cash to satisfy that reserve level because funds invested in MMFs will not fluctuate.98

In the case of same-day settlement by floating NAV MMFs, retooling would require major changes to the way pricing services and the Fedwire system operate, and ultimately may not be feasible. The Release points to a single floating NAV fund that offers same-day settlement of wire transfers, suggesting that MMFs need only modify systems to allow same-day settlement of redemption transactions. In fact, this change would require, among other things, a substantial overhaul of operations by third party pricing services. The earliest the pricing services will transmit valuations for money market instruments is after 4 p.m. EST. Currently, pricing services gather valuation information from market participants throughout the morning and early afternoon of each trading day to establish valuations as of 3 p.m. EST. The services then input this information into their valuation system and quality check the results, a process which itself takes over an hour. There is no guarantee that pricing services would be able to collapse this day-long process to a fraction of the time to accommodate the demand for intra-day pricing of money market instruments. Further, it should be noted that it took several years to convince pricing services to provide valuations as of the close of the New York Stock Exchange (in addition to 3 p.m. valuations), so pricing services may resist efforts to add more valuation times.

Additionally, in the absence of more frequent valuation to permit a fund to pay redemptions, a floating NAV MMF would be forced to send all wire transfer redemptions late in the afternoon, towards the close of the Fedwire, rather than throughout the day. This would impede the efforts of wire transfer recipients attempting to rewire redemption proceeds, and could greatly increase the volume of late day transfers over the Fedwire system, potentially beyond the systems capabilities. Having a single NAV calculation per day in a floating NAV fund would significantly inhibit investors access to cash and would further decrease the utility of MMFs overall.

98 Letter from American Bankers Association to SEC (Jan. 10, 2011). See also Letter from American Bankers Association to SEC (Sept. 8, 2009).

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A range of business functions would require costly overhaul.99 A floating NAV would disrupt numerous business applications that run on automated accounting and settlement systems designed for same-day settlement and rely upon a stable NAV. The effect on business and public accounting processes would be far-reaching and at a minimum would include: trust accounting systems